Japan's GPIF is right, short selling is downright irresponsible

When the Japanese Government Pension Investment Fund (GPIF) announced it was going to stop stock lending, the decision was met with a mixed response from commentators.

Among them was a damning conclusion from the Financial Times’ Lex column, which suggested this was another example of Japan Inc “scoring an own goal”. I could not disagree more.


The GPIF is one of the very few major financial institutions not only to have thought through its own broader responsibilities but also to have put its principles before easy practice. It highlights an important principle of good governance: that ownership brings both a responsibility and an opportunity to help create value rather than destroy it. Stock and bond markets, together with their investors, have a higher purpose than mere profit: their ultimate function is to provide capital to companies creating wealth for the benefit of wider society.


This is best achieved through taking a long-term perspective and considered decisions. However, our financial system has a vested interest in promoting short-term trading and speculation, rather than actual investment. This is where the practice of stock lending fits in. It is but one part of a highly profitable industry dedicated to the secondary trading of securities and their derivatives, that recognises little responsibility to society and accordingly contributes little to it.


What is the value created through stock lending? Those who defend the practice cite setting fair prices as an important outcome. But how valuable or helpful is this to the broader mission? Is such price discovery really helpful or necessary?

Activists can wield more positive influence if they buy shares rather than borrow them and continue to own rather than short-sell them.

There are increasing numbers of extremely successful companies growing to enormous size but opting to stay away from public markets that would disagree. So too would those family-controlled businesses, so numerous in Europe, that think in terms of generations rather than milliseconds. For many such companies, among which can be counted some of the very best long-term wealth creators, price discovery is an irrelevance.


What such companies do find helpful are shareholders who share their focus on the long term and who can engage constructively on meaningful issues, such as corporate strategy and allocating capital. Yet here too we often see a difference of views originating from different time horizons, with some focusing on maximising profits today and others advocating heavy investment for tomorrow. Shareholder activism is good, but activists can wield more positive influence if they buy shares rather than borrow them and continue to own rather than short-sell them.


Stock lending runs counter to constructive engagement and can be downright irresponsible, most particularly when an investor’s voting rights are temporarily transferred to third parties with diametrically opposed interests. Why then would any responsible long-term investor indulge in stock lending? The answer, of course, is for profit. Yet the rewards are small; we estimate that GPIF earns revenues of about 2.5 basis points from this activity and that fees to financial intermediaries account for almost a third of the income. Returns are very skewed to a small number of stocks that short sellers are keen to get hold of.

[Short selling]...is far from nice and has nothing to do with investing. 

So, would enabling short selling, which has a significant impact on a small number of share prices, reduce the GPIF’s portfolio by more than 2bp a year? This is impossible to answer but if you accept that short selling must have some negative impact on share prices, then the benefits of lending are quickly offset. Unless, of course, you are among those lucky intermediaries pocketing that one-third share of the revenues with minimal risk or cost.


What Lex described as “a nice little earner” is certainly little in the context of the funds involved but is far from nice and has nothing to do with investing. Baillie Gifford does not lend out stocks for our investment trusts or mutual funds, though many of our segregated clients do so, by their own choice. GPIF should be applauded for taking the long term and principled view of its responsibilities and hopefully more of our clients will follow its example.


This article was originally published in the Financial Times. 

Charles Plowden

Joint senior partner

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